Slumpflation – why don’t the authorities care?

I have long been predicting slumpflation. It was inevitable, given the wild fiscal policy and the manic monetary policy the government and Bank are following. Figures for the last quarter show that is exactly what we now have.

Manufacturing output is down a massive 13 % on a year ago. Why didn’t the authorities cut interest rates in 2007, when some of us urged them to do so, to cut the prospective decline in output in Q4 2008 and Q1 this year? The likely crash was obvious. Mr Blanchflower on the MPC foresaw it as well. Unemployment soared by 244,000 in the first quarter, and by 268,000 in the last three months.

Meanwhile, consumer price inflation as measured by the CPI, the government’s chosen measure and the one used for the Bank of England’s target, rose at a 2.9% annual rate last month. That is a massive 45% over target, and a high rate of inflation for a country experiencing a slump.

Why didn’t the MPC heed the inflation warnings some of us made in the second half of last year? Why didn’t they leave interest rates at say 2%, to offer savers some return and to send a signal they were not going soft on inflation and the value of the currency? Why didn’t they see that too large a devaluation would trigger further inflationary rises?

Has the MPC given up on watching inflation and trying to hit its target? Do they expect the slump to take care of all problems? Whilst most commentators expect price inflation to fall more in the next few months, we do not wish to see the seeds of the next inflation sown at the same time.

They should look at the recent performance of oil prices. They are today around 70% above their lows of earlier in the year. It looks as if the money from money printing on both sides of the Atlantic is finding its way into share prices and commodities.Some people call that inflation.

The authorities are getting themselves into the pickle of having no good choices left. If they are not careful we will end up with more of the same – slumpflation.

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19 Comments

  1. Ian Jones
    Posted May 13, 2009 at 6:35 am | Permalink

    There is little doubt that the Bank has abandoned its inflation targets and gone for outright inflation in order to prevent deflation.

    The end result of trying to print your way out is as you state slumpflation where the impact on the economic growth is the same but inflation is at a higher rate. It is classic rational expectations but it seems they consider this as better for the electorate with those overvalued houses.

    Have to disagree with your praise for Blanchflower, this is the man who flew in for MPC meetings from the US and who was calling for lower interest rates even at the height of the boom way before rates were raised. If we had listened to him we would have had much higher inflation before the bust!

  2. Demetrius
    Posted May 13, 2009 at 6:38 am | Permalink

    “Fantasia”, the Disney film of long ago. The part where Mickey Mouse is The Sorcerer’s Apprentice. Perhaps the government should take a look at it.

  3. Stuart Fairney
    Posted May 13, 2009 at 6:43 am | Permalink

    I think they called it stagflation in the late 1970’s but cause and effect are the same. Have an over mighty state sector, tax the life out of the wealth producing sectors to fund the state and watch output collapse and inflation jump.

    For my part, I’m more or less out of sterling and into asset classes of various types as I fancy the fun is about to start.

  4. John Moss
    Posted May 13, 2009 at 7:10 am | Permalink

    I thnk we’re in for a double dipper recession. Minor signs of growth will give the impression of recovery, but the inflation unleashed by QE will raise interest rates and depress us right back down again.

    Tin hats!

  5. Kevin Lohse
    Posted May 13, 2009 at 7:16 am | Permalink

    Dear John. You are not alone. I have been posting the odd comment on the possibility of a return to “stagflation” for about a year now. The economic conditions seemed to get closer and closer to those of the mid-70’s with every announcement from the Bank and the Treasury. This time round, the English Disease has mutated into a global virus. Once again, a socialist government has substituted dogma for science and hence has no idea of how to manage the down-turn/depression/slump. I hope you get a treasury post in DC’s first administration. a decade of good housekeeping is needed to enable this country to survive.

  6. Colin D.
    Posted May 13, 2009 at 7:18 am | Permalink

    The warnings of deflation were a Government orchestrated con. There was never a real risk of deflation. The Government WANTS inflation to reduce their debts and to win votes from the profligate. The MPC now behaves as simply as a tool of Government, pretending to focus purely on a low inflation target, but their actions (or lack of it) show that they are in fact engineering the inflation that Brown needs.

    • Stuart Fairney
      Posted May 13, 2009 at 10:58 am | Permalink

      Yes indeed, the deflation stuff was a Fig-leaf to justify the money printing, (otherwise an admission of total failure).

      And inflation seems the only way out from under these debts.

    • chris
      Posted May 13, 2009 at 2:35 pm | Permalink

      I think this is why the inflation measure that was generally used in reporting inflation was recently changed from CPI to RPI. As this measure includes interest rates it showed minor deflation. What was not mentioned was this was government created deflation and was not being reflected elsewhere in the economy. When interest rates are cut as heavily as they have been and this reflects in such a small drop I don’t think that can really be termed deflation. Yet it was enough of an excuse to agree printing huge sums. Oh dear.

  7. RobertD
    Posted May 13, 2009 at 7:22 am | Permalink

    The problem is the government deficit. The B of E is just frantically trying to find ways of helping the government sell its new debt and stave off the arrival of the IMF. Any thought about the long term stability of the economy or next year’s inflation rate has long gone out of the window.

  8. mikestallard
    Posted May 13, 2009 at 7:55 am | Permalink

    The revelations of mean spirited (and indeed pure greed itself) accountancy in the ranks of all MPs has had one wonderful result: we realise once again, for the second time, reiterated, that POLITICIANS ARE NOT TO BE TRUSTED, any more than anyone else.
    Already there are some checks and balances being thought up. this could well mean that some sense will be brought into cutting back the gross State in the near future which seems to me to be the real cause of the problem.
    It is simply no good putting everyone on the state payroll when the country’s industries and manufacturing output fold. It won’t work, inflation or no inflation.
    Socialism has had its day (except in the EU).

  9. Robin
    Posted May 13, 2009 at 7:57 am | Permalink

    A few important points John,

    Firstly, the excellent report by the Institute of Economic Affairs which lays naked the poor decision making and regulation by this Government that has led to the credit problems. It saddens me to realise that the last trigger for a finanical crisis, exiting the ERM was also politically motivated. Indeed the Labour Party were the more motivated politically to join the ERM in the first place.

    It’s interesting to look at both the Credit and ERM triggers and where they happened in the economic cycle. I take the view that there is not a simple cycle. There are investment cycles and asset cycles – and the two are closely linked. The 1987 privatisation/investment bubble popped an was followed by the 1991 housing crash bubble. More recently the dot com business bubble was followed by the credit crisis/housing bubble. All bubbles were different, but all the same in nature underneath.

    A few things to comment on this. First the investment bubbles are business oriented and the asset bubbles are retail oriented. Investment bubbles hit the investment oriented businesses and asset bubbles hit the retail oriented businesses. At the moment we see retail side of banks being hit, but record profits in the investment banks. Keep faith with this model. It works.

    Both bubbles are are caused by too much cash and optimism in either the business or retail sectors. Big bang, privatisation, housing, dot com, cheap debt. All of these characterise bubbles and were recognisable as such before they burst. The known unknown has always been the trigger, not the bubble. This bubble WILL burst should be the mantra – how can we lessen the bubble and lessen the impact.

    I think its true to say that … Politicians don’t cause booms – but investment and asset booms have been allowed to get bigger by politicians to make themselves more popular. Politicians don’t cause busts, but asset bubbles have been burst by poor political regulation causing trigger events.

    Now I don’t believe you can eliminate economic cycles, but you can lessen them. I also believe that politicans should play a role in lesseninng these bubbles. Politicians don’t like to dull optimism, but they can dampen it. They can also use tax AND negative tax to divert energy away from the bubbles. It is the politicians responsiblity to regulate the nation, not just the market.

    Having said all of this there are also long term trends, and one of those is a growing world population. The BRIC countries drove up inflation – and it was only last year we were looking at 150 for oil, and oil prices about to trigger a recession. I believe it was President Bush who (was forced to) allowed the Iraqis deal directly with the oil companies – and not via the US Government that stopped the oil lines being sabotaged and reduced OPECs hold on the oil price.

    So the price of oil came and went (and other resource inflation), but the underlying trend has not been dented. Sure demand for goods from the West has reduced inflation, but demand from the West will come back and demand from the BRIC countries themselves will just keep rising. I remember the potato farmer who couldn’t find packaging for his crop because the Chinese had bought all the wood. Resource price inflation will return.

    Governments can control bubbles, but global inflation bubbles they cannot control. I can see the next investment bubble will be in resources. Some of it will be real but a lot of it will be hot air. On top of higher taxes, utility bills and fuel bills wil rise, the cost of raw materials will rise. The trigger for the bubble will be the realisation that the price of resources is over inflated. I guess an event will lower demand slightly and the price will fall drastically.

  10. Brian Tomkinson
    Posted May 13, 2009 at 8:04 am | Permalink

    Many of us have written for some time that inflation is part of the plan for resolving the massive government debt. No one in authority is going to admit it though.

  11. Acorn
    Posted May 13, 2009 at 9:59 am | Permalink

    As little as we poor taxpayers are allowed to know, it appears that all that crispy new cash that the BoE has printed, got stuck at the first set of traffic lights out of Threadneedle Street. It then turned back and parked in the BoE “reserves” car park.

    We must assume that the banks are still waiting for all that “toxic” traffic to be cleared from the roads. Including all those toxic vehicles still parked in the back streets, waiting to do a ram raid on a passing high street bank cash truck.

    Two articles worth a read for anyone who has ever tried to read a banks financial accounts.

    http://www.dollardaze.org/blog/?post_id=00627

    http://www.dollardaze.org/blog/?post_id=00628

    • Denis Cooper
      Posted May 13, 2009 at 3:11 pm | Permalink

      Well, yesterday £2.25 billion of it found its way across to 11 Philpot Lane:

      http://www.dmo.gov.uk/documentview.aspx?docName=/gilts/press/120509conventional.pdf

      “RESULT OF THE SALE BY AUCTION OF £2,250 MILLION OF 4¾% TREASURY GILT 2030”

      and is now en route to paying the government’s bills.

      I expect the rest will follow later.

    • Adrian Peirson
      Posted May 13, 2009 at 7:23 pm | Permalink

      The Banksters are holding onto the Cash injection till the country Collapses, then they will be able to buy everything up for Pennies.
      Simple really.

      • Denis Cooper
        Posted May 14, 2009 at 9:44 am | Permalink

        Well, almost all of the newly created money is destined to pass through the gilts market into the Treasury coffers, after which almost all it will be dispersed across the country when the government pays its bills. In the sense that it will end up in one personal or company bank account or another, you’re right that it will then be with the banks. Some will be sent abroad, either by the government itself or by those who receive it from the government.

  12. alan jutson
    Posted May 13, 2009 at 10:36 am | Permalink

    The problem as I see it at the moment is that the Government are making too many decisions, too quickly, without first seeing what effect decisions which have already made, are having.

    Thus the true effect of any action taken is difficult to quantify.

    The real skill is in light touch movement.

    Its like flying a glider or a plane, a small movement of the stick has a real directional effect in a sensible time scale.
    A tug on the stick produces extreme movement, which then requires immediate correction.

    Heavy touch could be likened to being in a Dodgem Car. Oversteering which often needs overcorrection.

    The real problem is having someone in charge that can forsee the consequenses ahead of time, and can anticipate and apply light touch, so that heavy touch is not required.

    From what we have seen so far, Labour do not seem to have such skills.

    So we have a Dodgem Car Policy, where nothing is stable for long, and long term planning is difficult.

  13. Denis Cooper
    Posted May 13, 2009 at 3:26 pm | Permalink

    If you read the exchanges of letters about the Asset Purchase Facility:

    http://www.bankofengland.co.uk/markets/apf/index.htm

    the “quantitative easing” is being done in the name of monetary policy, to ward off the threat of a deflationary spiral.

    So today’s Quarterly Inflation Report

    http://www.bankofengland.co.uk/publications/inflationreport/ir09may.pdf

    has put off the day when the Bank will decide that it can no longer justify printing money to rig the gilts market.
    “CPI inflation remained close to 3%, significantly higher than the 2% inflation target. Past falls in sterling continued to put upwards pressure on inflation. But the degree of spare capacity in the economy increased further and the loosening in the labour market contributed to a sharp easing in pay pressures. CPI inflation is likely to drop below the 2% target later this year. Under the assumptions that Bank Rate moves in line with market rates and the stock of purchased assets financed by the issuance of central bank reserves reaches £125 billion, it is more likely than not that CPI inflation will be below the 2% inflation target in the medium term.”

  14. Hugh
    Posted May 13, 2009 at 6:22 pm | Permalink

    John,

    When I was younger there was a man called Friedman who showed a close relationship, with a judicious lag, between the money supply and inflation.

    This makes sense to me as the value of anything, money included will be affected by the supply of it.

    As you are up-to-date on such things, do you think think Friedman’s relationship still holds? And which published money supply measure is best for showing the future of inflation?

    All the Best

    Reply: Yes, of course there is a relationship. Remember it is relationship depending on both the quantity and the velocity of circulation of that stock of money. The authorities currently believe the transmission mechanism – the banks – are so broken that velocity will be low or fall further. I look at the normal measures of money growth. There is no perfect one to predict future inflation.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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